Question

Introducing Students to the FASB Codification System 163 The Accounting Educators’ Journal, 2011 Case 3 Sublease You are an audit partner in Slick & Co. CPAs. Mann Co. has been an audit client for ten years. Mann Company is owned by Lisa Mann who is a very astute businesswoman but she is not at all knowledgeable about GAAP. In fact over the years she has complained about the “stupid GAAP rules”. Lisa has built Mann into a $100 million in sales company that went public several years ago. You ran into her waiting in line at a restaurant and she indicated that she had a problem you need to address for her. She said: “ I know you remember all of the equipment we leased about three years ago. Remember, we had disagreements on how the lease should be handled. You made us treat it as a purchase and record a related liability of about $5 million, as I recall. The lease was an eight-year lease and we have been depreciating the asset over the lease term. As you know, our business has been expanding rapidly and the leased equipment is no longer adequate for our needs. We have decided to buy or lease new high output equipment. The lease on the original equipment allows us to sub-lease the equipment, which is our plan since the lease has another four to five years to go. My question to you is, if we sublease the equipment can we take it and the related liability off our books? We really need to get that debt off our books. Perhaps you could tell me how we should structure the deal so that we can get the liability off the books.” At this point Lisa was told that her table was ready so she needed to rejoin her party. She said “Would you please write a letter giving your advice and please give me specific references to GAAP so that my controller can review the materials with me. Thanks so much for your help on this. I really need to join my friends….. Try the Veal Marsala…it is great here!” Write a memo to Lisa Mann providing the information she requested.

Answer 1

To,

Lisa Mann,

Mann Company.

Subject: Accounting treatment for lease of assets.

Respected madam,

This letter is in reference with the above subject matter. In US GAAP ASC 840 all necessary provisions have been made in relation to the lease and sub-lease thus an organization in the US must follow these provisions while recording the lease transactions in their books of accounts. It is important to make it clear that until unless the lease ends and all payments are made as per the lease terms and conditions the liability relating to the initial lease cannot be taken off the balance sheet of the company. However, there is nothing to stop the company to enter into a sub-lease or another lease to acquire machines required for expansion of the business.

Thus, it is clear that the current liability in relation to the lease in the books of the company cannot be taken off the balance sheet until unless all necessary payments in relation such liability is made to the lessor.

Date:

Place:

                                                                                                Thanking you,

                                                                                                (Name of the student)